How to Use a Mortgage to Renovate Your Shabby House and Turn It Into the Home of Your Dreams

In some parts of the United States, homes tend to be very old. With that comes wear and tear along with obsolescence. And, with the surge in home improvement shows this century, Americans are increasingly eager to remodel their bathrooms, kitchens and more.

Unfortunately, home improvement isn’t free. Materials must be purchased and, in many cases, contractors must be paid. As such, home improvement loans are often in order.

How can you use a mortgage loan to renovate your shabby house and turn it into the home of your dreams?

Traditional Borrowing Options for Home Improvement Loans

If you decided to reenact the movie Cast Away for the past few years, I have some bad news: there was a major financial crisis with a load of banking scandals including bad home loans and other money mischief. Borrowing is more difficult than it used to be.

Still, traditional lending options may be at your disposal.

The first option is a home equity loan. This is a lump sum loan taken against the value of your home which is paid back via monthly installments. However, as Greg Cook, senior loan officer at Platinum Home Mortgage in Temecula, California notes, “that option has been pretty much non-existent since most lenders got out of that market when values tanked beginning in 2007-08.”

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A close cousin of the home equity loan is the home equity line of credit (HELOC). As with a home equity loan, a HELOC is taken against the value of your home. As Cook mentions, HELOCs “work well for renovations because a homeowner only repays for the portion of the line that he/she uses.” In other words, a HELOC is similar to a credit card in that you only repay the amount you borrow.

But, Cook cautions that, since HELOCs are equity-based, “Most homeowners don’t have enough equity to get one and they’re based on current value.” Consequently, you’ll only be able to borrow what you’ve paid into the house so far, not the entire value or more.

Finance a Home Purchase & Renovation with a 203(k) Loan

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For those wondering how to finance a home purchase and renovations, a lesser-known but viable alternative is a 203(k) loan. According to Cook, “A 203k allows a home buyer or homeowner to purchase/refinance a home and include the renovation costs up to 96.5% of the after-renovation value of a home. 203ks can be a great way for a homeowner to add equity to his current home or for a home buyer to purchase a home that is undervalued because of its condition and make it their own.”

For example, suppose you want to purchase a $200,000 home and make $35,000 worth of improvements. If you go with a FHA loan, the maximum amount you could borrow is $193,000, given the 3.5 percent down payment requirement. That would leave you with $42,000 in out-of-pocket expenses to both purchase and repair your new home.

However, if you secure a 203(k) loan, you could borrow up to $226,775 (96.5% of $235,000) and pay a more reasonable $8,225 out-of-pocket. Thus, with a 203(k) loan, you’d be able to borrow more than the purchase value of your home, pay a lower mortgage down payment and make the necessary repairs.

Potential Drawbacks to Borrowing for Home Renovations

Borrowing money to finance home renovations can pay off handsomely in the form of having a nicer home to live in. However, most homeowners recoup 60 to 90 percent of their renovations expenses upon sale, meaning the cost of renovating typically exceeds the gain in resale value.

Also, consider that, since you will take on additional debt, your interest expenses will increase accordingly and home improvement loan rates may not provide the same competitive options as a traditional mortgage loan.

Additionally, not all home renovations are welcomed by future buyers. For example, real estate website Zillow.com suggests that over-the-top landscaping, Jacuzzis, swimming pools and other such features could turn away those who are not interested in dealing with the related upkeep or safety issues. So, unless you plan to live in this home forever, be careful about spending a lot of money on home improvements most buyers won’t care for.

That said, if your home is currently in an uninhabitable condition or you’ve tried to sell it without any luck, borrowing money to fix it up may be necessary. With this in mind, note that, according to a 2012 report by The National Association of Realtors and Remodeling magazine, upgrades to doors, siding and windows are the three areas that pay off most (although they still cost more than the related increase in resale value). Such features boost curb-appeal, which naturally draws in more buyers. If you’re looking to make some home improvements that will get as much money back as possible upon sale, those are the best areas of your home to target.

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